Qihoo 360 Finally Starts to Monetize Its Search Business

Qihoo 360 (NYSE: QIHU) was trading higher by 4% after delivering a phenomenal quarter in which it beat both revenue and EPS expectations. Qihoo 360 and competitor Cheetah Mobile (NYSE: CMCM) have reaped the rewards of a growing mobile market in China by selling security applications. However, it's not Qihoo's security business that's creating excitement. The enormous opportunity that exists in taking on search giant Baidu (NASDAQ: BIDU) is.

As expected, mobile impressesQihoo 360 sells security applications in both the PC and mobile space. In previous years, the company's PC operations served as its backbone, but with 497 million users, its growth has slowed significantly. Albeit, in looking at Qihoo's first-quarter earnings, one can't help but notice the rate at which its Mobile Safe application has grown.

In the first quarter, Qihoo's Mobile Safe application grew a whopping 96%, to 538 million users. That has been key to the company's growth. While not fully responsible, mobile was the company's fastest-growing segment and likely played a large role in Qihoo's 120.9% growth in advertising revenue.

Given this impressive growth, investors might also want to track Cheetah Mobile in the coming months, as it competes against Qihoo 360 in mobile. Currently, Cheetah Mobile has 225.5 million mobile users of its security application.

Last year, Cheetah's revenue grew 160% to $120 million, and was able to generate an operating margin of 12%. Qihoo's operating margin was 24%. With that said, it's clear that the mobile security industry in China is still in its growth phase, and after witnessing Qihoo's momentum in the first quarter, investors have to like companies that have direct exposure to this space.

Search finally drives growthWhile security applications represent a great growth opportunity, it does have upside limits and likely has few barriers to entry. As a result, Qihoo has been hedging its growth in the security business by building a rather sizable presence within Internet search. This was put on display during the first quarter.

For example, in the fourth quarter, Qihoo reported its search market share to be 23%, but in the first quarter that share rose to 25%. Currently, Baidu is China's search leader with a 58% market share, but due to the rise of Qihoo, Baidu's share has fallen significantly from the 75% it owned in years past.

Qihoo has leveraged its large user base in security to build a growing search business, but the problem has been a lack of monetization. In fact, Qihoo doesn't even report revenue from search due to it being insignificant. However, investors have to like that Qihoo specifically mentioned improved search monetization as a reason for its accelerated growth in the quarter.

Quarter/Year

Year-Over-Year Revenue Growth

Q1/2014

141.3%

Q4/2013

115.3%

Q3/2013

124%

Q2/2013

108%

As you can see, Qihoo's revenue growth accelerated rapidly in the first quarter, which can be directly tied to the company's improved monetization efforts in search. Moreover, its second-quarter revenue guidance of $300 million -- $30 million better than expectations -- shows that these monetization practices might be having a significant effect on the company's fundamentals.

Notably, Baidu is a company that creates nearly all of its revenue by monetizing search, and it earned $5.7 billion in the last year. With Qihoo's search business quickly approaching half the size of Baidu, there is reason to believe that Qihoo could create billions in annual revenue from this one segment, and that we're now seeing the initial stages of this transition.

Final thoughtsQihoo's growth in search and the monetization of this business might be the greatest single asset for the company and for investors. In the past, Qihoo just wanted to gain market share, but now it's clear that creating revenue and profits is the goal. Therefore, Qihoo's continued growth in mobile remains a positive. But in looking ahead, investors should be especially thrilled about the future in search.

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